How to find yield in a low-rate world
If you’re starting to plan for retirement, odds are you’ve been told to reduce your exposure to risky stocks and add more safe haven bonds. That’s typically what financial planners and investment strategists advise, because bonds provide steady income payments.
But does that strategy still make sense at a time when US long-term Treasury yields are near historically low levels of around 1.5%, and bonds in Japan, Germany and France are actually sporting negative yields?
Probably not. Experts say that it might be time to buy more stocks.
“You’re not getting much yield, if any, or growth from bonds. So even conservative investors have to look more at high quality stocks,” said Kevin O’Grady, a portfolio manager at Miracle Mile Advisors.
Many leading tech companies have started to pay dividends. That’s a good sign because they give investors the best of both worlds: dependability and growth.
“Companies with strong business models and high profit margins will be more resilient in any downturn,” he said.
Dividends are divine in a low rate environment
Pre-retirees and retirees in particular are concerned about the bond market, said Ephie Coumanakos, managing partner with Concord Financial Group.
“People are nervous about stocks but also frustrated by low interest rates. So where do you go for income?”
She said investors should be able to generate 4% annually just from stock dividends as long as they focus on financially healthy companies that are able to to keep growing their dividend payments.
Of course, even dividend-paying stocks could be hurt if the US economy eventually — or as some would argue, inevitably — falls into recession. The recent inversion of the yield curve is an ominous sign, even though recessions have tended to start anywhere from 18-24 months after short-term rates top yields on longer-term bonds.
Recession fears aside, there are also legitimate worries that the US-China trade war will hurt corporate profits for leading US blue chip companies like Apple, Coke, GM and Caterpillar.
But real estate investment trusts, which tend to pay big dividends, look relatively attractive, noted Rich Kleinman, managing director of research and strategy for LaSalle Investment Management.
“When interest rates are lower, investors hungry for yield can look at real estate,” Kleinman said. “REITs have elements of bonds and stocks and are skewed toward conservative investors because they provide more stable income.”
Investors need to pick their spots with REITs because the US economy is slowing. The latest jobs report, which showed that just 130,000 jobs were added in August, is the latest sign of that.
Kleinman said companies that own medical offices and residential apartments are good bets even if the economy cools further. He’d be more wary of retail and industrial property owners.
If the American economy continues to lose steam, Treasury yields could go even lower, says Jon Adams, senior investment strategist at BMO Global Asset Management. He believes US corporate and municipal bond yields may head south too.
That’s a key reason why Adams believes investors should be focused more on dividend stocks. He points out that the average dividend yield for the S&P 500 is now about 1.9% — higher than the yield for the US 10-Year Treasury and not far below the 30-Year bond’s yield of 2%.
Some bonds are still attractive
But that’s not to say that all bonds are going to be a black hole for investors with a long-term horizon. Adams said there are pockets of the fixed income market that still look attractive, such as emerging market debt.
Yes, it’s true that political instability in some emerging markets, such as recent concerns about Argentina due to a weak economy and high inflation, are an issue. But he argues that the high payouts from emerging market bonds outweigh these concerns.
The SPDR DoubleLine Emerging Markets Fixed Income ETF pays a 4% yield, for example, while the iShares J.P. Morgan USD Emerging Markets Bond ETF has a 5.4% yield.
“Politics are always important in emerging markets, but that’s why you get paid a high yield. And issues like those in Argentina are still relatively isolated incidents,” Adams said.
Concord Financial’s Coumanakos also thinks conservative investors can profit from owning bonds if rates continue to fall. Keep in mind that bond prices move in the opposite direction of yield.
“Bonds can be productive if you play it from a price perspective instead of buying them for yield,” she said.
Now is a time for investors to re-evaluate what’s in their portfolio in light of the heightened concerns about the global economy. But that doesn’t mean you should panic.
“There is anxiety. There are no two ways about it. But it’s not time to pull the trigger and sell everything,” Coumanakos said. “Will things implode? Not yet — but we are being very vigilant and looking for signs of trouble ahead. That’s why there is something to be said about staying diversified.”